Jumbo Loans, Where Art Thou?

Between May 4, 2007, and Nov. 7, 2008, the spread in wholesale interest rates between a $417,000 loan eligible for purchase by Fannie Mae and Freddie Mac and a $418,000 loan that is not eligible increased from 0.28 percent to 2.97 percent. Loans eligible for purchase by the agencies are called “conforming loans.” Loans larger than $417,000 are called “jumbos,” and borrowers who need one today face a perplexing array of choices.

Until July 1, 2008, the agencies could not purchase jumbos. However, as the private secondary market in jumbos deteriorated in late 2007 and early 2008, Congress passed the Economic Stimulus Act of 2008 in February 2008. Among other things, that bill authorized the agencies to purchase jumbos in high-cost areas. The allowable size of jumbos on single-family properties can range up to $729,750, depending on house prices in the county in which the property is located. This authorization for the purchase of jumbos lapses after Dec. 31, 2008.

To complicate matters further, in July, the Housing and Economic Recovery Act of 2008 set permanent jumbo size limits that will kick in beginning January 2009, provided the current limits are not extended. The permanent limits are similar but lower, with a maximum of $625,500.

Contrary to what Congress evidently expected, conforming jumbos are not priced the same as conforming loans of $417,000 or less. On Nov. 7, 2008 when the wholesale rate on a conforming $417,000 loan was 5.76 percent, the rate on a conforming $418,000 loan was 6.33 percent. This was far better than the 8.73 percent on a nonconforming $418,000 loan, but why is there any difference at all?

Part of the reason is that the agencies are charging more on jumbos, presumably because they are more costly to process, more risky or both. A second reason is that the secondary market is treating jumbos as a special category of loan that may not be marketable through the efficient TBA (“to be announced”) pooling process. A TBA pool is the collateral for a mortgage-backed security that is priced and traded before the security is issued. Jumbos can comprise only 10 percent of the mortgages in a TBA pool, which allegedly lowers the price investors will pay for it. This treatment of jumbos might be temporary.

Given the current state of the market, borrowers today should place themselves in one of three groups. If they need a loan of less than $417,000, using a mortgage bank or mortgage broker will assure that their loan will end up with one of the agencies, and that their loan provider will have access to the best prices available. Borrowers remain vulnerable to excessive markups, however, which is why I recommend Upfront Mortgage Brokers (UMBs) for those who need handholding, and Upfront Mortgage Lenders (UMLs) for those who want to control the process on the Internet.

If a borrower can’t meet the agencies’ credit, documentation and other requirements, they may still qualify for an FHA loan. Some of the UMBs and UMLs offer FHAs, and other FHA lenders can be found at http://www.hud.gov/ll/code/llslcrit.cfm.

If the borrower needs a loan larger than the agencies’ current jumbo limit in the county in which the property is located, the best option is to shop depository lenders — commercial banks, savings and loan associations, and credit unions. But this can be quite a challenge because of the wide disparity in their prices.On Nov 12, I shopped for an $800,000 30-year fixed-rate mortgage on Mortgage Marvel, an online site that I reviewed a month or so ago. The mortgage companies on the site quoted rates of 8.125 percent to 8.375 percent. The credit unions and banks, in contrast, quoted rates ranging from 5.875 percent to 7.875 percent. I have never before seen rate differences on the same transaction this large. They no doubt reflect wide differences in lender access to funding, which is symptomatic of a market in turmoil.

If a borrower qualifies for a conforming jumbo, meaning that he needs a loan larger than $417,000 but no larger than the jumbo limit for the county in which the property is located, he can probably do best following the procedure described above for a $417,000 conforming loan. Since he will be paying a significant premium over the price of a $417,000 conforming loan, however, he might also check out depository sources. He also needs to be mindful that the current jumbo size limits are good only to year-end unless Congress extends them. Otherwise, they will be replaced by the lower permanent limits.

The writer is professor of finance emeritus at the Wharton School of the University of Pennsylvania. Comments and questions can be left at www.mtgprofessor.com. What’s your opinion? Leave your comments below or send a letter to the editor. To contact the writer, click the byline at the top of the story.